Bitcoin Bubble?

If you’re new here, you may want to subscribe to my RSS feed. Thanks for visiting!

Bitcoins are interesting as they don’t produce income like equities, bonds, or property, but they’re a lot more useful than gold, which varies in popularity as an investment option.

If you’re a fan of Graham and Buffett then you’ll presumably see Bitcoin as a bad investment like gold – no fundamentals and a value dictated purely by the market. There’s also no notion of seniority for certain Bitcoin holders to get some of their money back if the whole market goes belly up.

The case for Bitcoin, however, is in their usefulness for international transactions. If they become popular, and we need a supply of $1 trillion worth of Bitcoin to handle the mass of everyday transactions, then each Bitcoin (~10 million presently) needs to be worth $100,000 if all of them are used for these transactions.

The question you should be asking, then, is whether Bitcoin will become a popular system for conducting transactions. If yes, then it’s seriously undervalued. If no, then it’s just a bubble, and you would be speculating, rather than investing, to get involved. I think Bitcoin has already shown that it has some real demand as payment method for anonymous transactions (buying selling small amount of drugs, porn, murder for hire(?), … and also for legitimate privacy needs). The question is, how big is the potential market?

Deflationary design works against payment use of Bitcoins. Increasing number of transactions with deflationary asset creates more hoarding and speculation. Transactions must use less Bitcoins, making them more valuable and making speculators richer. That is, until some big player decides to cash in, creating a huge drop in value.

If Bitcoin becomes successful, I suspect that following will happen: There will be two kinds of users – speculators and people who use it as payment system. Those who use it for payments avoid holding Bitcoins as much as possible, because holding Bitcoins without intention of speculation is not a good idea. They buy/sell Bitcoins only moments before they buy/sell a physical product or service, because they want to avoid volatility. Presence of speculators creates huge instability because velocity of money will always come from the relatively small percentage of monetary base.